Investment Review & Outlook

Transcription

1 Investment Review & Outlook December 31, Investment Review and Outlook We d like to provide you with a perspective of the equity markets for the past year as well as common and uncommon themes for The charts in the package will help us make four points. 1. How political events have influenced the financial markets since the peak in October That there has been a recent split in performance between domestic securities and international markets. 3. Why investors should keep the faith if they own international and emerging market assets. 4. Why investors should stay the course with diversification. We will then explain secular markets and discuss what might lie ahead. And lastly, looking toward 2012, we will share our research we call Common Uncommon Themes for

2 Market and Economic Data Oct 2007 Market High S&P 500, 1576 Sept 2008 Fannie Mae, Freddie Mac, AIG Fail S&P 500, 1267 Mar 2008 Bear Stearns Bankruptcy S&P 500, 1278 Sept 2008 Lehman, Wash. Mutual Fail S&P 500, 1192 Nov 25, 2008 TARP announced S&P 500, 857 Feb 2009 QE1 Expanded $787B Stimulus Pkg S&P 500, 789 Mar 2009 Market Low S&P 500, 676 May 6, 2010 Flash Crash S&P 500, 1128 Aug 2010 QE2 Announced Dec 31, 2010 S&P 500, 1257 Dec 31, 2011 S&P 500, 1257 Aug 2011 S&P Downgrades US Debt S&P 500, 1200 Davidson Wealth Management 2 This slide shows the market, utilizing the S&P 500, since the peak in October You'll note on the vertical axis, the price of Standard and Poor's 500 starts near You'll note the horizontal axis carries us from January 2007 to November That market decline from October 2007 to March 2009 was the worst since the Great Depression where a credit shock occurred, resulting from 25 years of debt buildup. Only in hindsight, we can see widespread over accumulation of debt. Homeowner's aspirations of larger and larger homes, investors seeking higher and higher yields, financial institutions that facilitated and obscured the risk are all to blame. Note the subsequent recovery that began with an economic stimulus, since referred to as Quantitative Easing, followed by QE 2. Note on the far right hand side, the August 2011 time period that included debt ceiling negotiations, a downgrade of the U.S. debt, acknowledgment by Ben Bernanke of a slowing economy and his announcement that interest rates would stay low until June This also coincided with the beginnings of the European debt crisis recognition. Whew! The straight red line on the right side, illustrates that a calendar year is an arbitrary data point. You can choose any one year period and get a different slope! This reminds us that stocks are longer term investments than for just one year. 2

3 Market and Economic Data Slow Climb Back Oct 2007 Market High S&P 500, 1576 Oct 2007 High to Dec, 31, % Dec 31, 2011 S&P 500, 1257 Oct 2007 High to Mar 2009 Low -57.1% Mar 2009 Market Low S&P 500, 676 Mar 2009 Low to Dec 31, % Davidson Wealth Management 3 This is the same chart with a different insight. The blue line at the top shows that over three and a half years the market has still not recovered. The red line illustrates a drop of 57.1% The green line shows a stock market recovery of 85.9% from the bottom, but that it still does not overcome a drop of 57.1%. This illustrates one of the puzzles of mathematics that requires a much larger recovery off the bottom to break even. For example, if you had a $100 investment in ABC Co. and the stock value dropped 50%, you would have an investment worth $50. If the stock were to subsequently rise 50%, your investment would be worth $75. You would need a 100% increase in value from the initial 50% drop to $50, to get you back to break even or to a $100 value. Investors should also note you can draw a fairly steep line from the bottom illustrating a strong V-shaped recovery off the bottom, then a breather in the market, and then another steep upward line, about the time of QE2. Now we're experiencing another breather. We think this chart will set the stage later for a 2012 outlook that offers some encouragement going forward. 3

4 Market and Economic Data Global investing was not rewarded in 2011 S&P 500 Index ASCI All World Index S&P 500, , One year return = 0% S&P 500, , ACWI, , ACWI, , One year return = -9.9% 4 Global Investing Was Not Rewarded in This colorful slide illustrates the recent separation of the US and international markets. On the vertical axis, in blue, is the price scale for the Standard & Poor's 500, and the vertical axis on the right represents the MSCI All-World Index. The MSCI All-World Index represents the entire world's stock market, including both US and all other countries' markets. What is interesting to note is that from the time period starting from the bottom left-hand axis, January 2010, both markets traded in lock-step with oneanother until August of While the US market recovered, the international markets pulled down the All-World Index. Global investors temporarily lost money in It is important to note that during the last part of the year, the value of the dollar increased relative to other currencies, which in effect, gave a boost to the US market, allowing it to breakeven. You'll note on this chart the blue line that is horizontal, based only on price, offering a one year (price only) return of the Standard & Poor's 500 of zero. You'll notice the declining red line for the All- World Index illustrating a one year return of -9.9%. These do not reflect the actual returns of the respective indexes as they only illustrate price, but are illustrations to tell a bigger story; that investors were not rewarded in the past year for global investing. You might be thinking, Why not just keep my investment dollars here at home? 4

5 Market and Economic Data 5 The following two charts were provided to us by Russell Investments. This first chart refers to the ebbs and flows of international investing and rotating market leadership. The chart shows rolling 12-month excess returns, explained on the bottom. The time period, as shown in the bottom left-hand corner, runs from April 1, 2000 to February 1, 2011 illustrating that international stocks have had periods of both out-performing and under-performing the US markets. Note the bullet points on the right; global equity leadership changes frequently, reversals can occur quickly and dramatically, international equity returns have been higher than U.S. returns with higher volatility since 1970, and lastly, diversifying across markets can potentially capitalize on market swings. In short, using strategic asset allocation, investors should consider rebalancing annually which means putting additional dollars into the underperforming category of the past year - international markets - in spite of the short-term news that we're reading about Europe. Other than rebalancing, what rationale is there to invest abroad? 5

6 Market and Economic Data 6 Rationale can be found in the fundamentals. This page offers the perspective, that in spite of the current news coming out of Europe, Russell Investments suggests that US centric investing is a thing of the past. In terms of Global Market Cap, the United States currently only makes up 43% of all investable equities in the world, 15% is in the emerging markets. As noted, 40% of US company revenues are generated overseas and that there are higher economic growth projections outside of the United States. Russell Investments projects that in 5 years, 2016, gross domestic product will be dramatically skewed towards the emerging market nations often recognized as China, Brazil and Latin America, India, Indonesia, and South East Asia. If your time horizon exceeds 5 years, then as an investor you are forced to consider the argument of a broadly diversified strategy that includes international and emerging market securities. Just because investors were not rewarded for doing so in 2011 does not change the argument, in our opinion. As wealth managers engaged in asset allocation, you often hear us speaking of a bucket approach. We often hold cash buckets, invest in buckets of income securities and in growth strategy buckets. This particular discussion speaks to the growth bucket. Growth strategies accept short-term volatility and short-term disappointments. 6

7 Market and Economic Data 7 Why diversification? You may have seen this quilt before. Asset classes are stacked in order of performance each year beginning in 2001, beginning on the left of the chart. Take your pen and start at the top left corner in the red box which is Real Estate investments which happened to be the best performing asset class in From the left side of the chart connect the red boxes year by year. You will see how Real Estate has been the best performer and the worst performer over the last 10 years. Now begin at the bottom of the page and do the same thing by connecting the gray blocks, Commodities, which happened to be the worst performing asset class in You will note commodities have neither been consistently at the top or the bottom. Now, take a look at the white blocks which is an equally weighted blend of all the asset classes. Note that by blending strategies you will never be at the top and you will never be at the bottom. How does diversification help? It reduces portfolio risk, forces sell disciplines and keeps you invested in assets you might normally not have an affinity towards. By being well diversified, you experience a much smoother ride in your investment portfolio than by investing in one or two asset classes. 7

8 Market and Economic Data - Looking Back 8 We would like to introduce the terms secular and cyclical. A secular market is one that lasts 5 to 20 years. A cyclical market might last 1 to 5 years. There's no magic around the number. Secular is long-term, cyclical is short term. With this chart, Ed Easterling of CrestmontResearch.com takes much of the mystery out of bull and bear markets. On the upper section of the chart the vertical scale is a measure of wealth and the horizontal scale is time from 1900 to Note that the red sections represent years that the stock market did not make material progress, i.e. secular bear markets. The green sections are periods of time that the stock market made significant progress, i.e. secular bull markets. Looking at the bottom left-hand corner of the chart, the vertical axis is price to earnings ratio (P/E), i.e. the price that is paid for every one dollar of earnings of the stock market of the last year. The horizontal axis is time. Note a secular bear market starts when the P/E is high and ends when it's low. For the period from 1900 to 1920, you can see that the P/E started high and ended low a secular bear market. The implication is when the price is high, relative to the earnings per share, investors are more optimistic about the future and conversely, when the price is low, more pessimistic about the future. Now focus on the period from 1980 to In 1980, the P/E was around 8; a very pessimistic period of high inflation. In 2000, investor optimism drove the P/E to 40. Today, analysts tell us the P/E is now closer to 12 or 13 (see the red dot in the lower right-hand corner). Corporate earnings are up since 2000, but stocks are lower than 2000, because the price paid for each $1 of earnings is less. We think the chart makes two suggestions: 1. On a historic basis, the market is cheap, perhaps due to justified pessimism. 2. We are unable to identify the catalyst for optimism, but the chart illustrates the current course is unsustainable forever. 8

9 2012 Common and Uncommon Themes: Government problems worldwide attract media attention and drive asset price volatility near term. Corporate and consumer fundamentals continue to improve, unnoticed by media. (Our Fork in the Road theme.) Investors are likely to experience anxiety and fatigue, yet make financial progress. Common conclusions by economists and strategists Volatility remains high all year, driven early by policy-centric uncertainty of all governments, especially Italy. Strong U.S. Dollar whenever there is a back against the wall European scare. European recession, but no economic Armageddon, as the Euro survives as a currency. No U.S. recession. Repeat, no double dip. Low U.S. GDP growth and low interest rates stimulate interest in dividend paying stocks. WILD CARDS: Bad - Euro does collapse. Good - unexpected additional quantitative easing and policy agreements on both continents. Referred to as the Paranormal, replacing the new normal economy. We ask ourselves, How long can these or any theme be sustained? Davidson Wealth Management themes and principles for 2012 Global government deleveraging will continue for years to come. Get used to it. Reacting to politics has proven pointless. Resist the urge to trade reactively in Avoid high frequency viewing of economic data points and news. Most of today s current worries will be replaced by tomorrow s solutions and of course, new worries. Hold a little more cash than normal, not because the fundamental risks are so great, but because the human condition has become more reactionary and less thoughtful. We find investors with investment plans, driven by deep seeded values and a purposeful vision of the future, are the most hopeful. Our planning in 2012 will ask one question in short supply, What could go right? Davidson Wealth Management of Wells Fargo Advisors, LLC 9 9

10 Disclosures Wells Fargo Advisors did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request. Diversification does not guarantee profit or protect against loss in declining markets. Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets